Tompkins Associates and the Next Generation Supply Chain, Part IV

In Monday’s post, we brought your attention to Tompkins Associates‘ recent white paper on Leveraging the Supply Chain for Increased Shareholder Value which nicely complements CAPS Research and A.T. Kearney’s study on Value Focussed Supply: Linking Supply to Competitive Business Strategies and echos our cry for Next Generation Sourcing methodologies. A cry which has been taken up not only by The MPower Group (and spearheaded by Dalip Raheja who has declared that Strategic Sourcing is Dead and invited you to the The Wake for Strategic Sourcing) but by BravoSolution (who are rallying the battle cry for High Definition Sourcing and who have given us A Futuristic Look at High Definition Sourcing). We told you how they declared the need for a new Supply Chain Value Creation Framework and a renewed focus on business value in the supply chain, outlined three supply chain objectives — Profitable Growth, Margin Improvement, and Capital Efficiency, and described six primary types of value enabling actions to achieve the objectives before telling you that we would spend the next four posts discussing some of these actions and why Tompkins Associates‘ white paper on Leveraging the Supply Chain for Increased Shareholder Value should definitely be on your reading list as you outline your Next Generation Sourcing strategy.

So, today, we are going to discuss the objective of Capital Efficiency.

Capital efficiency is a measure used to determine whether a particular product, service, or operation is profitable, could be profitable with some adjustments, or should be abandoned entirely. The basic measure is computed by dividing the average value of output by the rate of expeniture for a period of time. A good capital efficiency is greater than one.

There are two primary ways for a company to increase capital efficiency. It can reduce working capital or improve the return on its fixed assets.

The most effective way to reduce working capital for many companies is to improve inventory management as significant amounts of working capital are typically tied up in inventory for an average company. The most effective reduction will be realizied when both cycle stock and saety stock is optimized. The white paper on Leveraging the Supply Chain for Increased Shareholder Value outlines four techniques that can be used to minimize cycle stock and four techniques that can be used to minimize safety stock.

With respect to improving return on fixed assets, a supply chain has four options. It can focus on the network assets, the building assets, the equipment assets, or the technology assets.

Technology assets need to be upgraded regularly or the cost to maintain the systems will increase as the risk of obsolescence skyrockets. Thus, a return on technology assets can be obtained by upgrading to a new system with addtional value before the technology becomes obsolete and the upgrade prohibitively expensive. (To determine how much the upgrade is going to cost, use the Cost Model Calculations in the SI Enterprise Software Buying Guide.)

Equipment needs to be maintained as no value can be obtained when it is not functional, and if it breaks down to the point of no repair, all value is lost. Thus, value is maintained when equipment is maintained. However, value can only be increased by upgrading to new, more efficient equipment that is easier to maintain, repair, upgrade, and control through modern control systems.

Building assets offer a fairy large opportunity for return on assets. If a building is appropriately designed for a function and has the right height, layout, and column spacing, no space will be lost, operations will be efficient, and, if LEED standards were followed, it will be energy efficient, cheap to maintain, and sustainable. Any building that is not used 100% does not deliver an optimal return. If a building is only partially used, a greater return can be obtained by leasing the unused space, or, if usage is sparse, disposing of the building and acquiring, or leasing, a more appropriate space.

Finally, the network offers the greatest opportunity for a large return on assets as an appropriate network realignment often removes 5% to 15% from total supply chain cost. A well designed network has low transportation costs, high agility, and (geographically dispersed) robustness and can withstand a disruption in part of the network. A good network is optimized, using the techniques outlined in SI’s three-part series on Supply Chain Network Optimization (Part I, Part II, and Part III), and stress-tested against multiple scenarios using a simulation tool.

All-in-all, a company has multiple options for increasing capital efficiency, just as it has multiple options to improve margins and achieve profitable growth. That’s why its important for a company to adopt a value-focussed mindset, implement next generation sourcing and supply chain practices, and chase the value that is just waiting to be extracted from the supply chain. And that’s also why it’s important to add papers like Tompkins AssociatesLeveraging the Supply Chain for Increased Shareholder Value to your working library as there aren’t that many resources out there that describe what a supply chain needs to do to get to the next level.